The way in which Spain absorbed German exports of savings is at the heart of the subsequent crisis. As long as Spain — thanks to the euro — could not use interest rates, trade intervention, or currency depreciation to block German exports, it had no choice but to import Germany’s excess, since investment and savings must balance. This meant that either Spain’s investment would have to rise or its savings would have to fall, or both.
Both occurred. Spain increased investment in infrastructure and in real estate, but it seems to have done both to excess, perhaps because of the sheer amount of capital inflows — its much- smaller economy was swamped by the large amount of German savings. After nearly a decade of inflows larger than any it had ever absorbed before, Spain, like nearly every country in history under similar circumstances, ended up with massive amounts of misallocated investment.
But this was not all. If the savings that Germany exported into Spain could not be fully absorbed by the increase in Spanish investment, the only other way to balance was wi
th a fall in Spanish savings. There are two ways Spanish savings could have fallen. First, as Spanish manufacturers lost out to German competition, Spanish unemployment could rise and so force down the Spanish savings rate (unemployed workers still consume). Second, Spain could have reduced household savings voluntarily by increasing consumption relative to income. Higher Spanish consumption would cause enough employment growth in the services and real estate sectors to make up for declining employment in the tradable goods sector.
Not surprisingly, given the enormous optimism that accompanied the creation of the euro, the latter happened. As German money poured into Spain, helping ignite a stock and real estate boom, ordinary Spaniards, especially those who owned their own homes, began to feel wealthier than they ever had before. Thanks to this apparent increase in wealth, they reduced the amount they saved out of current income, as households around the world always do when they feel wealthier. Together the reduction in Spanish savings and the increase in Spanish investment (in infrastructure and real estate) was enough to absorb the full extent of Germany’s export of excess savings. This happened in nearly all of the deficit countries in Europe.
But at what cost? The imbalance created by German policies to constrain consumption forced Spain into increasing consumption and boosting investment, much of the latter in wasted real estate projects. The moralizers who insist that Spain wasn’t forced into a consumption boom –”no one put a gun to their heads and forced them to buy flat-screen TVs” is the typical criticism — miss the point. Because Germany had to export its excess savings, Spain had no choice except to increase investment or to allow its savings to collapse, with the latter either in the form of a consumption boom or a surge in unemployment. No other option was possible.
The European crisis, in other words, had nothing to do with thrifty Germans and profligate Spaniards, but with policies aimed at boosting German employment, which also forced up German national savings rates. These excess savings had to be absorbed within Europe, and the subsequent imbalances were so large (because German’s savings imbalance was so large) that they led to today’s circumstances.
For this reason, forcing down the German savings rate substantially enough to give Germany a large current account deficit is the least damaging way to unwind the imbalances forced upon the region. Only in this way can countries like Spain stay within the euro while decreasing unemployment.
But lower German savings don’t mean that German families should become less thrifty — only that the average German household should be allowed to retain a much larger share of what Germany produces. If Berlin were to cut consumption taxes, or cut income taxes for the lower and middle classes, or force up wages, total German consumption would rise relative to GDP and so national savings would fall — without requiring any change in the prudent behavior of German households.
To ask Spanish households to be more „German” by saving more is not only impractical in an economy with 27 percent unemployment (unemployed workers cannot increase their savings), it is counterproductive. Lower Spanish consumption would cause even higher Spanish unemployment, until eventually Spain would be forced to abandon the euro to regain control of its ability to absorb or reject German imbalances.
As long as it is part of the euro, Spain has no choice but to respond to changes in German savings rates. This is the way balance of payments works. Thrift has little to do with it.
So clearly explained, and so easy to fix if only the German elite would let their compatriots enjoy more of their work results, by lowering taxes (VAT, petrol tax, income taxes for low and middle class etc) and/or encouraging higher wages.